PANC 2013: Fiduciary Fitness

“While we as advisers understand a lot of pieces of the
puzzle, the plan sponsor doesn’t,” Keith Gredys, CEO and president of Kidder
Benefits Consultants Inc., told attendees at the PLANADVISER National
Conference in Orlando, Florida.

Panelists discussed the different types of fiduciary and
fiduciary services that advisers provide, as well as fiduciary liability
concerns and prevention. “We throw these terms around a lot, but there are some
differences,” said David Kaleda, a principal with Groom Law Group Chartered. “A
3(21) fiduciary is a fiduciary because he or she exercises discretion over plan
assets or the investments of the plan, or provides investment advice for a fee.”

The 3(38) fiduciary, on the other hand, is either a
registered investment adviser (RIA) under federal and state law, or an insurance company or a bank, Kaleda said. “Those
are minimum requirements. That entity or person also agrees to be a fiduciary
with respect to the plan.”

Legally, the difference
between the two lies stems from section 402 of the Employee Retirement Income
Security Act (ERISA), which allows a named fiduciary to delegate investment
authority to a 3(38) manager. “Plan sponsors can push off most of their
responsibility,” Kaleda explained. “There is still a monitoring liability, but
they won’t be held primarily responsible for any investments.”

A 3(21) fiduciary can be helpful, but the scope doesn’t give
all the fiduciary delegation, and leaves someone else liable for investment
decisions. Yet the responsibilities of a 3(21) fiduciary are just as serious as
those of a 3(38), said Jake Downing, an attorney with Seyfarth Shaw LLP, even
though the 3(38) status carries more responsibility. “You’re telling the plan
fiduciary your advice with respect to that plan’s decisions about investments,”
he said. “The advice must be treated with necessary prudence.” I would always approach
it as if you’re fully responsible for that investment,” Downing said.

The ERISA Standard

Also consider some federal and state laws. “Remember that
ERISA is one regime,” Kaleda said, “but you are registered under state and
federal securities laws. There are different standards under the Securities
Exchange Act versus the Advisers Act of 1940, and those regimes are very different
from ERISA.” Obligations for an RIA are closer to those under ERISA, according
to Kaleda. “ERISA is the common standard, but on steroids,” he said. “It’s a
much higher standard.”

The biggest difference is that an adviser can disclose
conflicts, which can then be effectively negated, Kaleda said. “In ERISA, there
are a lot of exemptions, but none simply allow for disclosure. Some further
action is always called for.”

Advisers can position
themselves in several ways. At Commonwealth Financial Network, they manage
qualified retirement plans as a functional fiduciary or as a registered representative
working on a commission basis, according to Paul Mahan, vice president of
retirement consulting services at Commonwealth. Some of the firm’s advisers work
within the parameters of a 3(21) fiduciary, Mahan said, and a few act as 3(38)
managers.

“There should be more rigor around being a 3(21),” Mahan
said. “Some of our advisers are challenged by their clients, especially in the small-market
segment. You’re able to give advice at the plan level and participant level. But
the challenge comes if the plan sponsor does not act on that advice, because
their resources are constrained or they are working on other benefits, other
tasks. Our advisers can feel their liability is becoming more pronounced when
they give the advice as a 3(21) but the client does not act on it.”

“What we are seeing from the DOL [Department of Labor] is
heightened scrutiny about how people choose TDFs,” said James Lauder, chief
executive of Global Index Advisor and co-portfolio manager at Wells Fargo
Advantage. The funds can be trickier, and there is more to them than with
mutual funds.” The DOL released some tips,
Lauder said, but they may not reduce the fiduciary burden. (See “Incorporating
TDF Tips into Your Processes.”)

“Some of the points are very valid,” Lauder said, such as
the recommendation to have a documented process and the need to understand the
consequences of the fund’s glide path.

“Procedural prudence is key,” Kaleda said. “People who lose
the fee cases can’t document that they looked at things like institutional
share classes. They may have dismissed them for good reasons, but there’s no
record. If you don’t write it down, it’s really hard to prove what happened
three, four, six years ago.”

“Litigation is based almost entirely on lack of process,” Downing
added.

One trend could be custom-built TDFs, according to Downing,
who has one client rolling out all TDFs used in the plan that are based on the
risk characteristics of the plan population. Glide paths and fund beliefs were
considered closely in a very robust process.

“There is some expense but they shouldn’t have much risk
associated with those TDFs,” Downing said, “because they worked with their
advisers, based them on their populations and made them unique to their organizations.
It seems pretty bullet-proof.”